The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, trades on a negative note near 100.15 during the Asian trading hours on Tuesday. Dovish remarks from Federal Reserve (Fed) officials boost expectations for a rate cut next month, which weighs on the DXY.
Fed Governor Christopher Waller said on Monday that available data indicate that the labor market remains weak enough to warrant another quarter-point cut at the December meeting. Meanwhile, San Francisco Fed President Mary Daly stated that she supports lowering the interest rate next month because she saw a sudden deterioration in the job market, as both are more likely and harder to manage than an inflation flare-up.
New York Fed President John Williams noted on Friday that the Fed can still reduce the interest rates “in the near term” without putting its inflation goal at risk. The US Dollar softens against its rivals as traders raise their bets of a Fed rate reduction in December following these dovish comments.
According to the CME FedWatch tool, Fed funds futures are now pricing in nearly an 80% chance of a 25 basis points (bps) rate cut at the Fed’s December meeting, up from 30% odds that markets priced a week ago.
Traders will keep an eye on fresh US economic data later on Tuesday, with the US ADP Employment Change, Retail Sales, and Producer Price reports to be published. The US Producer Price Index (PPI) is estimated to show an increase of 0.3% month-over-month (MoM) in September, while the Retail Sales are expected to show a rise of 0.4% MoM during the same period. These reports could offer some insight about the US interest rate path. In case of stronger-than-expected US economic readings, this could lift the DXY in the near term.
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022.
Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.